Tobin's Q

Tobin's Q

Market value of assets divided by replacement value of assets. A Tobin's Q ratio greater than 1 indicates the firm has done well with its investment decisions. Named after James Tobin, Yale University economist.

Tobin's Q Ratio

A ratio of a company's market value to its total asset value. Tobin's Q ratio is based on the work of James Tobin, who suggested that a fairly priced company ought to have a price equal to its total asset value. Thus, when Tobin's Q ratio is less than one, it means that the market value of the company is less than the total asset value, indicating that it is undervalued. Likewise, when it is more than one, it indicates that the market value is higher than the total asset value and that the company might be overvalued. Tobin's Q ratio is also called simply a Q ratio.

We consider a particular theory of investment (known to economists as Tobin's q), but the crux of the argument is that stock market prices serve as a signal to firms' managers to buy new investment goods.

The story told by Tobin's q is, perhaps, overly stylized.

Nonetheless, the basic intuition underlying Tobin's q is compelling: Changes in stock prices should serve as a signal to firms' managers.

In addition, our source of replacement cost data is superior to that used in most studies which use Tobin's Q. The following sections of this paper discuss the data collection process and the methodology.

We conclude that, on average, the marginal and average Tobin's Q ratios differ for firms in the sample.

We use Tobin's q, the ratio of the market value of the firm to its replacement value, to measure the extent of a firm's growth options and flexibility to respond to new conditions.(6) Tobin's q increases as more of a firm's value is due to growth options, i.e., as the firm has increased flexibility in choosing its future path.

The other essential data observations needed for our hypotheses tests are the Tobin's q and market share of industry revenue data.

First, we divide the rival firms into two subsamples according to whether their Tobin's q is greater than or less than the announcing firm's q ratio.

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